• Monday, Feb 17, 2020
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What should be done about loan defaulters?

  • Published at 11:31 pm January 25th, 2020
Cut out the bad loans Bigstock

Shutter the firms that can’t pay them back

Much thinking is being done over what to do with the loan defaulters, those simply not paying back those non-performing loans (NPL) that so beset the banking system. The correct answer is to crush them so that we can hear the lamentation of their women. 

OK, Conan the Barbarian is perhaps a little bloodthirsty as a way to run a banking system, but the basic point still stands. People can’t pay back the loans they took out? OK, that’s fine, bankrupt them. This is not, it is necessary to note, because it is just and or righteous that they be punished in any manner. 

Rather, this is the very heart of what makes free market capitalism work. Work in the sense that it makes all of us out here richer, year by year, and decade by decade. This, of course, being rather the point of having an economy in the first place, that the people become richer.

People can’t add value to economic assets? Great, there’s no shame in that. But while there’s no shame nor punishment that should accrue, we don’t want people to be using economic assets that they cannot add value to. We want those resources instead to be used by other people who may actually be able to do something useful with them.

The background here is that we’ve a limited number of economic assets. Land, labour, capital, minerals, all those good things. The lifestyle we can live depends upon how much value is added to them through doing things with them. This is what Gross Domestic Product is, a measure of the value added -- no, it’s not economic transactions, or turnover, it’s value added -- in the economy. 

GDP is also, as well as the value that is produced the value of all incomes, or all consumption. For that’s what our incomes are, the value that has been added, that’s what we consume as well, value. 

So, how rich we are as a people or a country depends upon how much value is being added to those scarce resources we’ve got. All of this is by definition, this is not something that is arguable in any manner. We thus want to make sure that those assets, those resources, are in the hands of people who are adding value.

One way of doing this is that the government decides and that doesn’t have a good history. It always, but always, ends up being decided that who should have the assets are the friends of those who are the government. The one system that does work is this free market capitalism. 

All the currently rich countries have used this system, more or less, for many decades. All the countries getting richer are using it, roughly and around and about. Those places that don’t use it at all are still poor. This is as close to absolute proof as we ever get in economics, this is the system that works.

What this means is that anyone gets to try anything -- who knows, maybe it will be a good idea? But the really crucial part of the system is that it kills mistakes. Kills them as a working part of the system itself, no one needs to actively decide to winnow the ideas. If people can’t add value then they make a loss. 

Eventually, someone making a loss will run out of money -- they will go bankrupt. This is not an error in the system, this is the point of it.

For what happens in bankruptcy? All those economic assets, the land, the factories, the machines, the workers, are liberated and can now be employed again doing something else. Perhaps something that adds value this time. Sure, it might take a number of iterations before that new thing which does make us all richer is found. But it will be and this is the reason we have that bankruptcy.

If those assets remain with those who cannot use them efficiently then this makes us all poorer. We want, need, a method of killing off those experiments which have failed. 

Which brings us to non-performing loans. Those who have received bank loans in the past cannot pay them off. They have other assets – there’s still all that labour, land, and so on that they’re using. But by definition they're not adding value to them. If they were, they could pay the loans back. Shrug, time to kill those organizations. So that we can redistribute those assets to where they might be used to add value and so make us and the country richer.

It’s fair enough that we don’t do this immediately, this afternoon might be a bit too much of a shock. We need to protect the people who will be disturbed and discomfited by the change. But the organizations themselves? They’re not performing the very task that they exist to perform. 

Therefore we don’t want them to exist anymore. Close them down and use their component parts to do something else.

There is indeed something vicious, even barbarian, about free market capitalism and that’s the manner in which it closes down mistakes. The solution to NPLs is exactly that, shutter the firms that can’t pay them back and let’s see what else can be done instead. 

Tim Worstall is a Senior Fellow at the Adam Smith Institute in London.